Prime focus Leadership thought Basson Van Rooyen

By Penda Jonas Hashoongo
July 2016
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Before one the impact of a credit rating downgrade on Namibia, it’s important and worthwhile to explain two things. Firstly, what a credit rating is and what a credit downgrade is and secondly to put a historical context to this issue.

What is a credit rating downgrade?
A credit rating can be assigned to any entity that seeks to borrow money and plays a big role in helping with the pricing and risk management process of market participants. A downgrade means the credit rating agencies foresee a bigger risk in holding the debt of the entity.

The context
Impacts on South African economy
South Africa has been on a steady “ratings decline” for the past few years and in December the international credit rating agency Standard & Poor (S&P) put South Africa on a negative outlook that if another downgrade happens will move the government’s long-term foreign currency debt outside the investment grade range into what is referred to as “junk status”.

The term ‘junk’ is commonly, and perhaps harshly, used to describe any debt rated below investment grade.
What happens when a credit rating downgrade takes place is, firstly, investors would demand higher interest rates to compensate them for the higher risk involved meaning the government’s cost of borrowing would rise and bond yields will rise.

Over the medium term, higher borrowing costs would force the government either to raise more revenue via higher taxes or to cut spending in order to avoid widening the budget deficit.

SA government bonds in time will be excluded from global bond indices which have become popular benchmarks for index tracking funds frequently used by foreign institutional investors and certain international pension and sovereign wealth funds may be precluded from holding South African bonds.

The cost of borrowing for state-owned enterprises and private companies would also increase, which would likely dent corporate balance sheets, particularly those of companies that are highly geared and rely on borrowing, like property companies. This would in turn impact negatively on profits and investor dividends, trimming equity returns.

How does it affect Namibia?
Namibia’s credit rating has recently been reaffirmed by Fitch as BBB- and BBB with stable outlook for our Issuer Default Rating on long-term foreign and local currency debt respectively which is pretty much in line with our southern neighbour and because our economies are closely linked to that of South Africa, the likelihood of a future downgrade to our rating increases due to the close ties between our currencies and economies.

This may mean the effort to keep the Namibian expenditure under control and carry a healthy foreign reserve, could possibly not be enough in the eyes of the rating agencies.

The South African Rand and subsequently the Namibian Dollar operate within a flexible exchange regime and the price is set by the forces of supply & demand and due to the looming rating downgrade together with other factors like political instability, commodity price swings or global growth slowdown has an effect. We’re seeing more and more volatility in the exchange rates and most of the time unfortunately not in our favour.

A rise in our borrowing costs could also be a serious damper to our growth that as the cost of debt increases and weakening of international buying power, our budget deficit and infrastructure projects will be difficult to fund and we could see a difficult time expanding and creating new jobs.

A rise in the bond yields will filter through to the cost of borrowing for financial institutions like banks that will have to borrow at higher rates than before which will increase interest rates changed to bank lenders, which is unfortunately also being hit by an increase in the rate of inflation. This follows the trend of South African inflation over and above the 6% maximum target.

Conclusion
We should understand that the market is forward looking and seems like it has mostly priced in the potential downgrade in currency exchange levels and current bond yields and although we may have more volatility in the short term crossing the downgrading mark for South Africa will remove much of the uncertainty also being priced in by market participants.

Basson Van Rooyen
Portfolio Manager: Sanlam Investments